Managing retirement assets in the event of a layoff

These days, layoffs are a fact of corporate life as companies try to grapple with economic cycles and global competition. One of the first choices laid-off workers face is what to do with their retirement plan assets. Many, confronted with the prospect of meager unemployment checks and a long job search ahead, opt to cash out of their employer-sponsored retirement plan accounts.

But cashing out may be expensive, involving a large tax bite and loss of tax-deferred compounding of any potential earnings on one's hard-earned retirement nest egg. Moreover, there may be better ways to make ends meet while unemployed than dipping into retirement savings.

If you get caught in a downsizing and you're not immediately moving to a new company, you generally have three options for your retirement plan assets: (1.) Leave your money in the existing plan; (2.) take a cash, or a "lump sum," distribution; or (3.) transfer the money to another retirement savings account, such as an individual retirement account (IRA). Consider the merits of each option.Footnote *

Option #1: Stay put Generally, you may be able to leave your savings in your existing plan if your account balance is more than $5,000.Footnote 1 By doing so, you'll continue to enjoy tax-deferred or tax-free compounding potential and to receive regular financial account statements and performance reports. Although you will no longer be allowed to contribute to the plan, you will still have control over how your money is invested among the plan's investment selections.

Option #2: Cash out You may elect to have your money paid to you in one lump sum or, if provided under the plan's terms, in installments over a set number of years. A lump-sum approach has a number of drawbacks, including a 20% withholding on the pre-tax contributions and earnings portion of the eligible rollover distribution, which the plan sponsor is obligated to withhold to cover federal income taxes, and a 10% early withdrawal additional tax if you separate from service before age 59½. Depending on your tax bracket and state of residence, you may be liable for additional taxes. Taken together, you could lose up to 50% of your money to federal, state, and local income taxes. An installment approach, whereby distributions are made in substantially equal payments over the participant's and/or participant's and spouse's life expectancy, is not subject to withholding or early withdrawal additional tax. But this is a fairly complex option that may require the assistance of a financial advisor and your tax advisor.

Option #3: Roll over You can move your retirement plan money into another qualified account, such as an IRA, using a "direct rollover" or an "indirect rollover." Note that traditional plan balances can be rolled into traditional or Roth IRAs, however taxes must be paid on rollovers to a Roth. Any Roth contributions in your plan account can only be rolled into Roth IRAs. With a direct rollover, the money goes straight from your former employer's retirement plan to your IRA without you ever touching it. The advantages of a direct rollover include simplicity and continued tax deferral on the full amount of your retirement savings. In an indirect rollover, you take a cash distribution, less 20% withholding, but must redeposit your qualified plan assets into an IRA within 60 days of withdrawal in order to avoid paying taxes and early withdrawal additional taxes. With this approach, however, you'll have to make up the 20% withholding out of your own pocket when you invest the money in the new IRA, or else that amount will be considered a distribution and will be taxed, and a 10% additional tax will be applied (if applicable). IRAs may also afford more investment choices than many employer-sponsored plans.

The costs of cashing out *

Lump-sum cash distribution

$10,000

— less 20% tax withholding

($2,000)

— less 10% additional tax *

($1,000)

— less remaining federal and state taxes due **

($900)

Equals your net after-tax distribution

$6,200

* This hypothetical example assumes the individual is under age 55 for the entire calendar year in which the individual was laid off.

** This hypothetical example assumes a federal tax rate of 24%, a state tax rate of 5%, no local tax, and that plan balances are held in a traditional tax-deferred plan. Tax rates vary from state to state, and your rates will differ. This example has been simplified for illustrative purposes and is not meant to represent advice. Investment returns cannot be guaranteed.

Consider other short-term funding sources

During times of economic hardship, it may be tempting to take money intended for future needs and use it to supplement a temporary income shortfall. But before choosing a retirement plan cash distribution, look hard at other potential sources to meet your current income needs. Some of these might include:

Savings accounts or other liquid investments, including money market funds or other easily liquidated investments. With short-term interest rates at historically low levels, the opportunity cost for using these funds is relatively low.

Home equity loans or lines of credit are an one way to tap into the equity in your home. Not only do they offer comparatively low interest rates, but interest payments are generally tax deductible. The best approach here may be to set up an equity line of credit beforehand, while you are employed, so that funds will be available when you need them.

Roth contributions. If you do find it necessary to resort to using some of your retirement savings, consider first cashing in the contributed portion of your Roth IRA, if you have one. Amounts you contributed to a Roth IRA can be withdrawn tax free, since you've already paid taxes on them.

If, after everything else, you still find it necessary to cash in your retirement savings account, consider rolling it into an IRA first, then withdrawing only what you need. Also, try to time it after year-end, when you may be in a lower tax bracket. But remember that any funds you take out today and use will ultimately reduce your retirement nest egg tomorrow.

Compare retirement plan distribution options

By leaving your money in your former employer's plan... you may keep your long-term goals on track by continuing to pursue tax-deferred growth potential

By taking a lump-sum cash distribution... you may satisfy an immediate need for cash, but impede the long-term growth potential of your retirement portfolio and incur current tax liabilities and early withdrawal additional taxes (if applicable)

By making a direct/indirect rollover to an IRA... you will continue to pursue tax-deferred or tax-free growth while potentially having greater control over the assets

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You have choices about what to do with your employer-sponsored retirement plan accounts. Depending on your financial circumstances, needs and goals, you may choose to roll over to an IRA or convert to a Roth IRA, roll over an employer-sponsored plan account from your old job to your new employer, take a distribution, or leave the account where it is. Each choice may offer different investment options and services, fees and expenses, withdrawal options, required minimum distributions, tax treatment, and different types of protection from creditors and legal judgments. These are complex choices and should be considered with care. Visit http://www.merrilledge.com/retirement/rollover-ira or call a Merrill Edge® rollover specialist at 888.637.3343 for more information about your choices.

Footnote 1 Generally, if your account is less than $5,000, your employer can cash out your account. However, if your account has over $1,000 in it, your employer would have to roll over your account into an IRA in your name unless otherwise directed by you.

This material is authored by DST Systems, Inc. and was not authored by Merrill Edge. Assumptions, opinions and estimates constitute judgment from DST Systems, Inc. as of the date of this material and are subject to change without notice. Past performance does not guarantee future results. The information contained in this material does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security, financial instrument, or strategy. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue.

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